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Kathy Panagopouloskathy.panagopoulos@morningstar.com
Unloved Funds Could Yield Lovable Returns, Says Morningstar

CHICAGO, Jan 19, 2001 – Just as people cheer for the underdog in movies and in sports, Morningstar has found that sometimes the underdog wins in the mutual-fund industry. Today, Morningstar announced its annual "Unloved Fund Category" study, which identifies the three least-popular fund categories from the previous year.

Since 1987, Chicago-based Morningstar, a leading provider of investment information and analytical tools, has reviewed the percentage change in cash flows--the money going into or out of mutual funds. Morningstar found unpopular fund categories have beaten the average equity fund over the next three years more than 75% of the time. Further, unpopular categories have won out over popular fund categories 90% of the time.

"We don’t consider performance in our quest for unpopular categories; instead, we look at how the cash flow to each group of funds has changed in a given year," said Morningstar fund analyst Gabriel Presler. "We suggest buying one fund from each of these unpopular categories and holding it for the next three years. In other words, we’re asking investors to buy exactly what everyone else seems eager to dump."

Unlike in past years, there is a theme to this year’s winners--all are regionally focused funds in Asia. Funds investing in this area of the world lost almost 25% of their value in 2000, after posting an outstanding year in 1999 (the average Japan-stock fund returned more than 116% for that year).

Morningstar recommends buying funds from the following "unloved" categories:

  • Pacific/Asia ex-Japan – funds that invest 75% of stocks in Pacific countries, but no more than 10% of its stocks in Japan.
  • Diversified Pacific/Asia – funds that invest at least 65% of stocks in Pacific countries, with at least an additional 10% of stocks invested in Japan.
  • Japan – funds that invest at least 75% of stocks in Japan.

Morningstar suggests investors heed the following when investing in these funds:

Buy one fund from each of the unpopular fund categories.
While all three categories are from the same broad region, they will not necessarily perform the same way. Not every category will catch fire in the next three years, so it’s particularly important this year to invest in all three.

Limit the investment.
It’s wise to diversify so unpopular funds do not exceed 5% of an investor’s portfolio. This helps people avoid serious trouble if 2001 turns out to be one of those years where the "Unloved Funds" strategy doesn’t work (though it would only be the second time since 1987).

Use a tax-sheltered account.
Investments such as a Roth IRA can protect against the possibility of tax penalties that can arise due to active trading.

Buy soon.
Morningstar studies have shown that, generally, investors can buy the funds up to a year later and the strategy still works. However, prices in Asian markets can increase quickly, so the funds can get expensive just as quickly. It might be best to buy these funds early when stock prices are still low.

Two ways to play.
Put new money, such as a raise or bonus, toward these funds. Scale back on favorites such as specialty-health, specialty-technology, and mid-cap growth funds and move the profits from these funds to unpopular picks.

"Investors tend to be fickle, so it’s possible for a fund category to fall from grace very fast," Presler said. "Adhering to the 'unloved funds' strategy helps investors spread their investments and potentially maximize their gains."

This study appears in the January issue of Morningstar® FundInvestorTM, the company’s award-winning monthly mutual-fund publication, and on the company’s Web site.

About Morningstar, Inc.
Chicago-based Morningstar, Inc. is an independent provider of reliable, unbiased investment information. Morningstar.com is listed among the top investing sites by publications such as The Wall Street Journal, Barron’s, SmartMoney, Money, Worth, and U.S. News & World Report. Morningstar provides investment information for a number of leading Web sites, including Microsoft MoneyCentral, Quicken.com, America Online, Yahoo Finance, and Netscape Personal Finance.

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